Earned Income for Roth IRa
Hello,
At the beginning of 2009 I contributed $5,000 to my ROTH IRA assuming I would have earned income of at least $5,000 this year. I was planning on being employed in a “normal” job.
Well, circumstances have changed, and currently I am working full-time as a FOREX and stock day-trader. I am making income from both of these activites, however, I keep reading that gains from stocks cannot be counted as earned income because “investing is passive.” My question is: if stock trading (and foreign currency trading) is my full-time job, does this change anything? Can I use capital gains on day-trades to count towards earned income if this is my main source of income and what I use to pay bills?
If I cannot, then I will not have earned income of $5,000 for 2009. The $5,000 that I contributed for 2009 has appreciated considerably, so I have a horrible feeling that tax-penalties are going to take away all my Roth gains if I have to do an excess contribution for 2009.
Thanks for your help.
Permalink Submitted by Alan Spross on Fri, 2009-08-14 19:56
Getting your total trading entity set up for tax purposes is probably far more vital at this point since it involves elections that determine your taxable income with many more dollars at risk than an IRA contribution would provide. However, even if you elect the mark to market method which converts your profits to ordinary income from capital gains, the IRS has ruled that this is not considered taxable compensation for IRA contribution purposes. This means you have an excess contribution to correct. Options:
1) If married to a spouse with earned income, you can make a spousal Roth contribution for yourself.
2) If the gains in the Roth are large enough, you can elect to leave the excess in the Roth and pay the 6% excise tax for 2009. You can then apply the excess to any earned income you would have in 2010. Total tax cost is 6% of $5,000. You must remove the 5,000 by 12/31/2010 if you do not have earned income in 2010 to avoid a second levy of 6% as of 12/31/2010. Or you can wait and correct the excess up to 10/15/2010 if the gains disappear and you do not want to incur the 6% penalty.
3) You can arrange a small salary job to generate enough income to cover your contribution between now and year end, or do this next year and incur the 6% penalty for one year but preserve the gains by assigning the contribution to 2010. This carryover contribution is reported on Form 5329.
Permalink Submitted by Rick T on Sun, 2009-08-16 02:07
Thanks for the reply. IF I choose to pay the 6% tax, this doesn’t have to come out of my IRA account, right? In other words, I can pay the $300 tax from my bank account, correct?
I’m in a real pickle because it’s possible I will be a full-time student next year, in which case I don’t think I will make $5,000 next year either. But the gains in my roth have been substantial, like 40%, so it would kill me to take that out.
If I do a removal of excess contributions, I would have to pay a 10% fee on all my gains, correct?
Thanks for you help.
Permalink Submitted by Alan Spross on Sun, 2009-08-16 03:01
If you needed the funds, you could take an IRA distribution and pay the tax with those funds, but in most cases you would pay it with other funds.
You are correct that if you do a timely removal of the contribution (prior to 10/15/2010), the earnings would be taxable and subject to the 10% penalty for 2009. However, if you pay qualified higher education expenses in 2009, the penalty would be eliminated by the higher education exception. The penalty would be eliminated to the extent your higher education expenses covered the amount of taxable earnings. But the earnings will be taxable in 2009 even if you do not correct the excess contribution until 2010. If you pay the higher education expenses in 2010, you cannot use the exception to apply to the earnings taxable in 2009.
Looks like a case of weighing the 6% excise tax vrs distributing the earnings and paying taxes plus possibly 10% on the earnings.
Permalink Submitted by Rick T on Sun, 2009-08-16 03:40
Alright, I think everything’s clear, but just to be sure, if I choose the 6% excise tax option then I don’t pay a 10% penalty on earnings for 2009 but I do have to get earned income of $5000 for 2010, right?
Seems to me like that may be the way to go. Thanks for the help.
Permalink Submitted by Alan Spross on Sun, 2009-08-16 04:01
Yes, the 6% excise tax and the withdrawal of earnings are mutually exclusive, ie one or the other. The deadline to make that decision is 10/15/2010 for a 2009 contribution. After that date you would not withdraw earnings. However, you would have to withdraw the original contribution amount before the end of 2010 to avoid a second 6% excise tax for 2010 in the event that you did not have any earned income in 2010 either. If you will have earned income in 2010, then the 2009 excess contribution will be applied to 2010 and you will only owe the 6% tax for 2009. Of course, in that case you would NOT make another 2010 contribution to leave room for the 2009 contribution to be applied in 2010. Removal of the actual contribution amount will be tax free as it is a return of a regular Roth contribution.
This continues with a new 6% excise tax being incurred on each 12/31 that the excess contribution stays in the account.
Permalink Submitted by Rick T on Wed, 2009-08-19 23:33
Hello,
I just realized I might have one last resort as well. In 2008 I received non-qualified stock options in a company I sold my website business to. I haven’t exercised any options, but I was just thinking that if I do, this should generate ordinary compensation income, right? If I exercise enough options so that the excess fair market value of the stock over the option price is $5,000, then I should be all set, right? For example, if I exercise 1000 shares with a fair value now of $6/share and my option price to exercise was $1/share, then I will have to pay taxes on the difference ($5,000) as ordinary income, and hopefully this would let me keep my 2009 contribution to the roth. Plus this might be a good year to exercise some options since my tax bracket will be the lowest it’s been in a while.
Sorry for all the questions–this is it I promise, haha. You’ve been a big help, thanks so much for your time and advice.
-Rick
Permalink Submitted by Alan Spross on Thu, 2009-08-20 03:39
That should work. If the exercise of these options will generate a W-2 with the ordinary income in Box 1, it will qualify as earned income for purposes of an IRA contribution. I think you will also owe FICA taxes on this amount. I would suggest confirming with the company that the W-2 will be generated.
Permalink Submitted by mk foss on Thu, 2009-08-20 16:57
Often when options are exercised after someone has separated from service the income is reported on Form 1099, If it’s listed as Non-Employee compensation on the 1099-MISC it will be earned income and can support the Roth contribution. However, there will be SE taxes to pay – you pay both halves of the social security and medicare tax on Non-Employee compensation.
Permalink Submitted by Rick T on Mon, 2009-08-24 21:58
Thanks–one final thought I just had: if I have earned compensation income of $5000 but then have $3000 I can deduct for stock losses (or company expenses or some type of deduction like this) then would I still be able to contribute $5000 to the roth or would I only be able to contribute the net income which would be $2000?
-Rick
Permalink Submitted by Clyde Wolf on Tue, 2009-08-25 00:49
Moreliator,
Once you have the earned income, you can contribute the lesser of your earned income or $5,000. So if your earned income is $5,000 you can contribute the entire amount.
Capital losses would have a positive impact your MAGI for ROTH contributions.
In 2009, the phaseout to limit your ROTH contribution begins when your MAGI is $105,000 for single filers, and at $166,000 for MFJ.
Permalink Submitted by Rick T on Tue, 2009-08-25 01:11
Right, I understand that capital losses would be beneficial if your income is approaching the phase-out range, but I’m talking about losses when your earned income is only $5000. If I only earned $5,000 for 2009, for example, and wanted to contribute $5000 to my roth, can I do this even if I have capital losses of $3000 for 2009?
Permalink Submitted by Alan Spross on Tue, 2009-08-25 02:09
Yes, you can. Capital losses will reduce your AGI, but your earned income is not reduced by such losses. The same is true of self employment income. If you have a net loss from self employment and other W2 income, the SE loss does not reduce your W2 income amount for IRA contribution purposes.
Permalink Submitted by riiupw afrass on Sat, 2021-05-29 21:36
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